Finding the deposits is the first problem. The second, more significant problem, is mining them profitably. Scale is critical in mining—it takes years to invest in and build up the needed capacity, expertise, and people. Add in a national-security imperative and a focus by the world’s two leading superpowers and the field is likely to be even more challenging and combative.
The best way to analyze these dynamics is to employ the Porter Five Forces framework developed by Harvard business professor Michael Porter. This lets us examine the competitive dynamics of an industry and reveals its challenges.
Threat of New Entrants. The barriers to entry in rare earths-mining are high, which is a reason why China has been able to build its dominant position, making it difficult for others to compete. A key barrier to entry in mining is simply the access to ore. Finding it, and finding the kinds of high-grade ore that are less costly to process, is one challenge. Another is that unlike other elements, rare earth elements exist fused to other minerals and must be extracted through a complicated, and expensive, process. These factors make it difficult for new companies to succeed in the industry. This doesn’t mean US companies can’t compete—MP Materials does control the ore body at the Mountain Pass mine and Ramaco has a mine in Wyoming—but it will take a sustained effort and significant capital investments.
Bargaining Power of Buyers. Given China’s dominance of the industry, the bargaining power of buyers, who are wholly reliant upon the product, has been weak. The US government push to revive the industry (the Australian government is also taking strides to boost its domestic industry), however, is likely to strengthen buyer power. As federal agencies and large companies such as Apple and GM negotiate long-term contracts to help keep local, non-China based suppliers of rare earths afloat, these buyers will look to minimize prices. This is a mixed bag for companies in the industry. The effort to boost the industry may succeed, but it also may give buyers more options and stronger bargaining power longer-term. This is an underappreciated risk that could hurt profitability.
Bargaining Power of Suppliers. Processing rare earth elements requires specialized equipment and workers with expertise. This gives the industry’s equipment suppliers bargaining power over mining companies. Labor is also a challenge. Given the long drought in this industry in the US, there is a limited pool of workers with the specific knowledge and skills required for this kind of work. That gives them bargaining power over the companies as well.
Threat of Substitution. This is perhaps the area where the industry is the strongest, for the simple reason that currently there aren’t any alternative materials that easily replace rare earths.
Rivalry. Rivalry has been nonexistent, but may increase given the US government’s determination to rebuild the domestic industry. MP Materials is perhaps the most prominent US company right now, but it is not alone. Ramaco Resources recently released a preliminary economic assessment of its Brook Mine project in Wyoming, suggesting the project has a long-term EBITDA potential of US$143 a share per year, and a project life of more than 40 years. Lynas, an Australian company that trades in Canada, is building a processing plant in Texas. The combination of demand and government support is likely to lead to a situation where just as these companies are trying to build up their businesses, other companies are also sprouting up as well, which could lead to oversupply before any of them reach economies of scale.
The very thing that has some investors excited, therefore, is also a risk: the heavy role of government in the viability of these companies. What is good for the US government may not necessarily be good for minority shareholders. If these companies cannot show durable profit and growth without government support, is this truly a viable industry worth investing in?
There is a tough road ahead for sustainable growth and profitability in this industry, certainly for companies in the US, and even for companies abroad. The leading company in the industry, China Northern Rare Earth, supplied almost three quarters of all China’s rare earths, but its cash flow return on investment last year was only about 5%. In fact, over the past 20 years, its cash flow return on investment has been under 10% most years.
The rarest thing about rare earth elements ultimately may not be the elements themselves but profits and attractive returns for the companies trying to mine them.
